Maybe China’s Currency Isn’t Undervalued After All

Note to rest of the world: Stop bugging China on undervaluation of its currency.

The World Bank’s re-estimation of global pricing is leading to a second day of questioning of economic verities. Yesterday, a number of publications used the new numbers to pronounce that the U.S. would next year lose its century-long ranking as the world’s number one economy. (China Real Time came to a more nuanced—and skeptical—conclusion.)

Today, two economists at the Peterson Institute for International Economics, perhaps the world’s top econ think tank, used the numbers to conclude that the Chinese yuan was no longer undervalued, as it has been for decades.

“This estimate is of potential historic significance,” conclude Martin Kessler and Arvind Subramanian. “The end of Chinese mercantilism—and relief for the rest of the world—may be in sight,” they write in a Peterson blog post.

To review, the World Bank re-estimated the size of different economies using a calculation known as purchasing power parity (PPP), which tries to estimate relative wealth by looking at differing prices in different countries for the same goods or services. Such comparisons usually show that developing countries aren’t as poor as they seem. For instance: A haircut in Beijing costs far less than a haircut in Boston, which means the wealth of a Chinese person with a full head of hair –- let’s call him Mr. Wang—is greater than usually understood.

Cheaper in China: haircuts. Not cheaper: iPhones, BMWs and other imports.

Reuters

But Mr. Wang doesn’t buy things in PPP; he buys them using actual currency. When he leaves the hair salon and buys an import, say a U.S. iPhone or a German car, his yuan are converted into dollars or euros at the current exchange rate. Given that Chinese earn far less money than Americans or Germans on average, exchange rate comparisons accentuate the gap between developing and developed nations. Most comparisons of international power are done using the prevailing exchange rate, not PPP.

Now, back to the value of the yuan.

Messrs. Kessler and Subramanian use the new PPP calculations to estimate that between 2011 and March 2014 China’s per-capita GDP grew about 13 percentage points faster than the U.S., which they say should translate into a currency appreciation of around 3.2%. Since the actual appreciation was 7%, that suggests the yuan appreciated too rapidly during that period and made up for some of the time when the yuan didn’t strengthen rapidly enough. “The renminbi in 2014 is thus fairly valued,” they conclude.

Any estimate of a currency’s valuation is a black art. Different economists use different methods and come up with different conclusions, especially if there isn’t an obvious undervaluation or overvaluation.

It’s hardly surprising that many countries accuse the others of deliberately undervaluing their currencies, and use estimates of currency valuation to make their point. Nearly every government has the same strategy for growth — export more — and a cheap currency helps exporters.

The U.S. Congress has made China’s currency a political issue for years; before that, Congress’s target was the Japanese yen. Developing nations, in return, accuse the U.S., through the Federal Reserve’s bond-buying policy known as quantitative easing, of slapping a fancy name on a plan to drive down the value of the dollar.

The most likely outcome of the Peterson Institute calculations is that China will be able to point to them as a way to justify its currency policy and the U.S. Congress will do its best to ignore them.

Alan Tonelson, an economist for the U.S. Business and Industry Council, a business group that regularly accuses China of playing different games to disadvantage U.S. exporters, was dismissive of the Kessler-Subramanian calculations.

Although the yuan has risen substantially in value over the past decade, “that should not be confused with movement toward proper valuation because, during the period in question, China’s economic fundamentals improved so dramatically versus America’s,” Mr. Tonelson wrote in an email to China Real Time. “Indeed, it’s most reasonable to argue that the yuan’s appreciation brought it no closer to proper valuation during this period – because were it traded freely, it would have appreciated much, much more.”

The argument isn’t settled and likely won’t be soon, if ever. The International Monetary Fund is due to come up with its assessment of the yuan’s valuation during the summer. Last year, the IMF said the yuan was “moderately” undervalued—IMF lingo for 5% to 10% undervalued. The IMF figures China’s trade surplus will rise over the coming years. So it’s a safe bet that the IMF, which doesn’t use PPP, will again be in the yuan-is-undervalued camp.

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